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Tuesday, August 09, 2011

Standard & Poor's downgrade: Think about this

They have the authority they do because the government says so.

The one thing the US could do to punish Standard & Poor's is to no longer allow their ratings to have any regulatory value. If a company has to have assets of a certain quality, the judgment of S&P is no longer valid in determining whether or not you meet that requirement. (I have no idea on the legality of that, or whether or not it's a good idea.)

But think about this: In a free market, S&P should have gone out of business, since they so badly handled ratings of collateralized mortgage obligations. They gave a AAA rating to something that collapsed in value and security with a housing market downturn. They gave these ratings despite widespread thought that we were in a housing bubble. They didn't do one single sensitivity test?

Without the official recognition of government being involved, a competitor could have arisen, promising a more robust model for complex securities like CMOs. Instead, there's a practically insurmountable barrier to entry.